Choose your ‘flation

In the US we ignore food and energy costs to pretend we have low inflation. European nations are concerned about deflation, but Russia, India, Turkey, Venezuela, and several Gulf Coast nations are facing stagflation.

Europe’s low inflation rate has become the new focal point for those who believe the euro zone is doomed to disaster. Inflation in the zone fell to just 0.8% in December, well below the European Central Bank target of “close to but below 2%.” In Greece, inflation is already negative, while in Spain, Portugal and Ireland it ranges between 0.2% and 0.3%. That is fueling fears the currency area could tip into outright deflation, as Japan did in the 1990s when falling prices led to prolonged stagnation. Consumers held off purchases as they waited for goods to become cheaper, causing growth to stall and the debt burdens to rise.

The latest to lend its voice to the chorus of anxiety is the International Monetary Fund. Last week, IMF chief Christine Lagarde warned that deflation was a rising risk for the global economy, which could be disastrous for the recovery. “If inflation is the genie, then deflation is the ogre that must be fought decisively,” she said.

Russia’s economic growth has been slowing amid dwindling investment, hefty capital outflows, and weak demand and low prices for its commodities exports. Officials repeatedly downgraded forecasts for economic growth last year to 1.4%, a far cry from the average annual pace of about 7% during the early 2000s and well below the medium-term target of 5% set by President Vladimir Putin. Consumer prices grew 6.5% last year, above the 5%-to-6% range the central bank was targeting.

Would it be that when the next bubble bursts and the world realises that to have believed that ‘This Time Is Different’ is a folly again?
Rogoff: I don’t think that the United States is in for a lost decade like Japan. The United States has the shale gas proposition; the tax factor is strong. The US has done better than those who have experiences. They have regained their peak per capita GDP and it is growing. Eurozone certainly looks like going like Japan. They have not articulated the path to growth in Europe. They don’t seem to be prepared to write down debt of periphery countries. They seem to be limping from one quarter to the next. I don’t think the US is in that situation. I think they have near-zero interest rates because policy-makers are too rigid about 2% inflation in these extraordinary times. They are shy of telling their people that inflation is going to rise temporarily.

What about the Volcker rule which is said to be impacting the financial services industry?
Rogoff: I don’t think it is going to have such a big effect because what it is going to do is to lead to migration from the banking system to the shadow banking system which will not be regulated the same way. By the way, they know that. It will not have such a dramatic effect. It will figure in the compensation of some bankers and some people wish they were working in different firms. But, by and large, they have been doing everything possible to preserve the existing system because they were afraid what would happen if there is a big change. I think the US and the UK are deeply invested in preserving their financial sector.

One recurring concept is that deflation and stagflation in oil-producing countries will be driven by continuing unconventional oil production – shale gas, shale oil, tight oil, tar sands oil – in the US and Canada.

One piece of the jigsaw puzzle is missing to complete the deflation landscape across the West: a slide in oil prices. This is becoming more likely each month.

… markets face an “new oil supply glut” as three forces combine. US shale will add 1m barrels a day (b/d) to global supply for the third year running; Libya will crank up shipments after a near collapse in 2013; and Iran will come out of hibernation. “This will push OPEC spare capacity to levels last seen in the depths of the financial crisis in 2009,” he said.
America is on track to overtake Saudi Arabia as the top global producer of oil by 2016. It will account for more than half of non-OPEC world supply this year. The US Energy Department says US oil imports will drop to 5.5m b/d by next year, half the level a decade ago. This turns the world’s 89m b/d market upside-down.

What about oil depletion? How long can this North American oil rally last?

To avoid confusion, let me be clear that the dangers of dwindling oil supplies in the long-run have not gone away. Easy reserves of crude are being depleted. New fields are more costly. Peak oil may have the last laugh. Yet this should not be confused with the short-term risks of deflationary shock.